What Drives Royalty Rates in International Franchising?

Abstract

Royalty rates are an essential contractual provision to reduce the risk of opportunism in franchising partnerships, many of which are international. However, extant research provides limited insights into the factors that determine the level of royalty rates in international franchise agreements. To address this gap, the authors conceptualize and empirically test a model that treats country characteristics (economic potential, legal rights protection, and cultural distance) and contract characteristics (territorial exclusivity and contract duration) as drivers of royalty rates, accounting for product-market profile and service type as potential contextual factors. Using a unique data set comprising 125 international franchising contracts between franchisors and franchisees from 19 countries, the authors find that economic potential (but not territorial exclusivity) is associated with higher royalty rates while legal rights protection, cultural distance, and contract duration are associated with lower royalty rates. While these relationships are robust across B2C and B2B markets, the impact of economic potential (legal rights protection) on royalty rates is more (less) pronounced for people-processing services, compared to possession-processing services. This work extends the literature exploring the contracting stage of international franchising and provides insights that inform franchisors’ and franchisees’ decisions related to the design of such contracts.

Franchisors’ Strategic Pricing Approaches for Franchise Fee Decisions and the Moderating Role of the Competitive Condition: Evidence from the Korean Franchising Market

“…Prior researchers have investigated the factors that influence franchise fees mostly based on agency problems and have suggested that the fee structure is determined to minimize agency problems between franchisors and franchisees and induce the best efforts of each party during the contract period (e.g., Brickley 2002;Lafontaine and Shaw 1999;Maruyama and Yamashita 2012;Mathewson and Winter 1985;Roh 2000;Vázquez 2005). Specifically, Zeißler et al (2023) provided empirical evidence that factors to reduce the risk of opportunism (i.e., economic potential, legal right protection, and contract duration) are important for franchise fee decisions in the international franchise setting as well as in the national context, which confirms recent findings on the agency problems (Jayachandran et al 2013;Lanchimba et al 2018). These studies helped us learn the structural features of the franchise fee based on the contractual perspective.…”

Introduction to the Special Issue on Theory and Practice in Global Marketing (TPGM)

“…Finally, Zeißler, Mandler, and Kim (2023, “What Drives Royalty Rates in International Franchising?”) address an important gap in the extant literature by using an international EFF approach. They demonstrate that academic studies to date have investigated the “why,” “what,” and “how” criteria of international franchising, but not what drives the key aspect of royalty rates in international franchise agreements.…”